If a firm eases its credit policy by lengthening the

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Unformatted text preview: it period, relaxing its credit standards and collection policy, and offering (or raising) its cash discount, its sales should increase. However, its costs will also increase. A firm should ease its credit policy only if the costs of doing so will be offset by higher expected revenues. In general, credit policy changes should be evaluated on the basis of incremental profits. • Changes in credit policy can be analyzed in two ways. First, pro forma income statements can be constructed for both the current and the proposed policies. Second, equations can be used to estimate the incremental change in profits resulting from a proposed new credit policy. • With a regular, or simple, interest loan interest is not compounded; that is, interest is not earned on interest. • In a discount interest loan, the bank deducts the interest in advance. Interest is calculated on the face amount of the loan but it is paid in advance. • Installment loans are typically add-on interest loans. Interest is calculated and added to the funds received to determine the face amount of the loan. • The annual percentage rate (APR) is a rate reported by banks and other lenders on loans when the effective periodic rate exceeds the nominal periodic rate of interest. Questions (27-1) Define each of the following terms: a. Cash discounts b. Seasonal dating c. Aging schedule; days sales outstanding (DSO) d. Payments pattern approach, uncollected balances schedule e. Simple interest; discount interest, add-on interest (27-2) Suppose that a firm makes a purchase and receives the shipment on February 1. The terms of trade as stated on the invoice read “2/10, net 40, May 1 dating.” What is the latest date on which payment can be made and the discount still be taken? What is the date on which payment must be made if the discount is not taken? (27-3) Is it true that if a firm calculates its days sales outstanding, it has no need for an aging schedule? Problems 27-25 (27-4) Firm A had no credit losses last year, but 1 percent of Firm B’s accounts receivable proved to be uncollectible and resulted in losses. Should Firm B fire its credit manager and hire A’s? (27-5) Indicate by a ( ), ( ), or (0) whether each of the following events would probably cause accounts receivable (A/R), sales, and profits to increase, decrease, or be affected in an indeterminate manner: A/R Sales Profits The firm tightens its credit standards. ______ ______ ______ The terms of trade are changed from 2/10, net 30, to 3/10, net 30. ______ ______ ______ The terms are changed from 2/10, net 30, to 3/10, net 40. ______ ______ ______ The credit manager gets tough with past-due accounts. ______ ______ ______ Problems (27-1) The Boyd Corporation has annual credit sales of $1.6 million. Current expenses for the collection department are $35,000, bad debt losses are 1.5 percent, and the days sales outstanding is 30 days. The firm is considering easing its collection efforts such that collection expenses will be reduced to $22,000 per year. The change is expected to increase bad debt losses to 2.5 percent and to increase the days sales outstanding to 45 days. In addition, sales are expected to increase to $1,625,000 per year. Should the firm relax collection efforts if the opportunity cost of funds is 16 percent, the variable cost ratio is 75 percent, and taxes are 40 percent? Relaxing Collection Efforts (27-2) Kim Mitchell, the new credit manager of the Vinson Corporation, was alarmed to find that Vinson sells on credit terms of net 90 days while industrywide credit terms have recently been lowered to net 30 days. On annual credit sales of $2.5 million, Vinson currently averages 95 days of sales in accounts receivable. Mitchell estimates that tightening the credit terms to 30 days would reduce annual sales to $2,375,000, but accounts receivable would drop to 35 days of sales and the savings on investment in them should more than overcome any loss in profit. Vinson’s variable cost ratio is 85 percent, and taxes are 40 percent. If the interest rate on funds invested in receivables is 18 percent, should the change in credit terms be made? Tightening Credit Terms (27-3) The Russ Fogler Company, a small manufacturer of cordless telephones, began operations on January 1, 2004. Its credit sales for the first 6 months of operations were as follows: Monitoring of Receivables Month Credit Sales January $ 50,000 February 100,000 March 120,000 April 105,000 May 140,000 June 160,000 Throughout this entire period, the firm’s credit customers maintained a constant payments pattern: 20 percent paid in the month of sale, 30 percent paid in the month following the sale, and 50 percent paid in the second month following the sale. a. What was Fogler’s receivables balance at the end of March and at the end of June? 27-26 Chapter 27 Providing and Obtaining Credit b. Assume 90 days per calendar quarter. What were the average daily sales (ADS) and days sales outstanding (DSO) for the first quarter and for the second quarter? What were the cumulative ADS and DSO for the first half-year? c. Cons...
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